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A Prime Example Of Success In Strategy Implementation

Jordo is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Despite the long trough in natural gas prices, the stock of EOG Resources (NYSE: EOG) is near record highs. Below, I will explain how EOG's continued success in strategy implementation has led it to this point, and how this will enable the company to keep up its high rate of growth.

What Happened?

This strong performance has been driven by the successful implementation of the strategy to generate organic growth in production by focusing more on profitable crude oil and liquid production. This diversification strategy has been capital intensive, but the further growth of proved developed liquids-rich plays should continue to strengthen the balance sheet and support high valuations.

Like other U.S. natural gas producers Chesapeake Energy (NYSE: CHK) and Devon Energy (DVN), EOG has reacted in recent years to declining natural gas prices by investing heavily in the acquisition of leased acreage in unconventional oil plays. EOG has invested more than $16 billion in just the last three years in the acquisition and development of shale assets, such as Eagle Ford and Permian Basin in Texas and Bakken acreage in North Dakota. The company has not damaged its balance sheet to finance the transformation like some of its peers.

Financials 

As of September 30, 2012, EOG had cash and cash equivalents of $1.1 billion, resulting in non-GAAP net debt of $5.2 billion and a net debt-to-total capitalization ratio of 27%.The company has demonstrated significant progress in transitioning to more profitable hydrocarbons, and this is reflected in the growth in sales and operating margins. Oil and natural gas liquids are expected to make up approximately 86% of 2012 sales, up from a mere 29% in 2008.

Drivers Behind Strategy Success

The success of the strategy is a combination of higher crude oil production volumes and higher crude oil price realizations in tandem with lower well and unit costs and reduced natural gas operations which are unprofitable. Total crude oil and liquids-rich natural gas production is expected to grow around 38% to about 215 million barrels per day (Mbd) for 2012, up from 35% in 2010. The company expects that North American gas production will shrink another 9% in 2012 on top of a 7% sequential decline in 2011 and it plans to pursue a minimum of drilling activity of gas in 2013. EOG has prospered from its early mover advantage in key resource plays, like Eagle Ford and has been able to maintain one of the best organic oil growth rates in the industry.  However,   reserve replacement costs will remain an area of concern in the future because only around 39% of EOG’s net proved reserves of 2.05 billion barrels of oil equivalent consist of crude oil and condensate.

Is EOG An Acquisition Target?

Chief Executive Officer Mark Papa and Royal Bank of Canada have speculated that EOG is a likely acquisition target. EOG has exceeded analysts’ consensus earnings estimates for eight straight quarters. In November, EOG estimated 2012 production growth at almost double the rate it had estimated in February.

According to Miller Tabak & Company, EOG has some of the best acreage in North America’s leading shale formations, the Bakken and Eagle Ford.

According to the same report, Chevron (CVX) is a likely suitor given that its cash holdings are more than 60% of EOG’s market capitalization.

Peers

EOG's stock performance has surpassed its peer group so impressively that many investors may think it is overpriced. EOG is up 20% over the past year, while shares of its gas-rich competitors Chesapeake Energy and Devon Energy are down. Even the high-flying Continental Resources (NYSE: CLR) has shown less impressive gains.

Chesapeake Energy soared 7% on the announcement that CEO Aubrey McClendon will retire on April 1, 2013. McClendon’s actions have dogged Chesapeake's stock price over the past two years. Chesapeake has fallen 32% since 2011, dissolving a significant portion of the company’s market value.

EOG and Continental stand out in this group because of substantial heavy liquids production justifying a higher valuation. The key to their success is their domination of the two most highly regarded oil shale plays in North America. EOG is now the leading unconventional oil producer in its peer group, with substantial operations in both the Eagle Ford and Bakken. Its first mover advantage allowed it to acquire an impressive acreage portfolio, and production growth is the key to its success, with liquids accounting for almost half of total production. Continental’s high valuation is similar because it is located in the Bakken and is the leading producer and landholder in the Williston Basin. 

This is in sharp contrast with cheaper names like Devon and Chesapeake, both of whom are pursuing liquids production with some success, but their acreage positions are not near the quality of portfolios of first-movers like EOG and Continental.  Chesapeake may appear to be cheap at its current price but has many problems to be resolved before it should be bought. 

Conclusion

EOG has comfortably outperformed its peers. It has demonstrated its ability to grow production of oil and liquids, and the quantity of its shale production acreage should enable it to keep up this growth. I recommend buying EOG Resources today.


jordobivona has no position in any stocks mentioned. The Motley Fool has the following options: Long Jan 2014 $20 Calls on Chesapeake Energy, Long Jan 2014 $30 Calls on Chesapeake Energy, and Short Jan 2014 $15 Puts on Chesapeake Energy. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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